Markets Rebound – Words & Actions

July

01

The Markets

Soothing words from Federal Reserve Bank officials helped settle investors’ fears last week, and U.S. stock markets moved higher. The Dow Jones Industrials Average was up 0.7 percent, the Standard & Poor’s 500 gained 0.9 percent, and the NASDAQ rose by 1.4 percent.

Markets were more stable during the week, and the CBOE Volatility Index (VIX), which gauges investors’ fear by measuring volatility expectations for the coming 30-day period, fell by 2 percent to finish the week just below 17.

Economic data was mixed. On the negative side, U.S. Gross Domestic Product (GDP) growth from January through March was revised downward from 2.4 percent to 1.8 percent annually. On the positive side, U.S. home prices gained more than 12 percent in April, which was the biggest year-to-year gain since 2006. Home sales for May also were strong, reaching a level last seen six years ago, according to the Denver Post. For a full report check out our Economic Notes blog entry HERE

Gold suffered another difficult week. Some believe the sell-off is the result of changing expectations as fear that quantitative easing might lead to hyperinflation, systemic collapse of the financial system, or devaluation of currency have begun to ease.

U.S. stock markets delivered positive performance for the quarter, as well. The Dow gained 2.3 percent, the S&P 500 was up 2.4 percent, and the NASDAQ rose by 4.2 percent. Year-to-date, the S&P 500 gained more than 12 percent during the first six months of 2013. That was its best first half of the year performance in more than a decade, according to Yahoo! Finance.

This week, some experts foresee the possibility that Fourth of July fireworks could be followed by a new round of market volatility as investors and analysts try to use the June employment report to predict the timing of monetary policy changes.

Data as of 6/28/13

1-Week

Y-T-D

1-Year

3-Year

5-Year

10-Year

Standard & Poor’s 500 (Domestic Stocks)

0.9%

12.6%

20.9%

14.3%

4.7%

5.1%

10-year Treasury Note (Yield Only)

2.5

N/A

1.6

3.0

4.0

3.5

Gold (per ounce)

-8.0

-30.0

-23.5

-1.9

5.1

13.2

DJ-UBS Commodity Index

-2.2

-10.5

-4.6

-0.3

-11.8

0.7

DJ Equity All REIT TR Index

4.0

5.6

12.7

16.3

7.6

11.0

They say actions speak louder than words…

but that doesn’t appear to be the case when it comes to Federal Reserve monetary policy. For some time, the Fed has been communicating its intention to gradually cut back its bond purchasing program (a.k.a. quantitative easing) while keeping the target fed funds rate steady. The target fed funds rate is the interest rate at which banks borrow money from each other overnight. The Fed has not taken action yet, but its words have caused nominal bond yields to rise and inflation expectations to fall. Typically, these changes are associated with tightening monetary policy.

The Fed’s words also triggered significant market volatility. An article in The Economist suggested:

“Fed officials are doubtless annoyed by the market’s skittish reaction to the idea of tapering. In its view a more leisurely pace of buying does not amount to tightening. Fed economists reckon the size of the central bank’s balance-sheet is what matters most: so long as its asset pile is growing, policy is getting looser. By the Fed’s estimates, halving the monthly rate of asset purchases would be equivalent to trimming the federal-funds rate by five basis points per month instead of ten.”

The gap between the Fed’s perceptions and the markets’ response has been significant, and investors and analysts are scrambling to interpret the economic tea leaves. Researchers at Barclays Capital, whose work was cited in The Economist, have tried to determine how tapering may affect investment assets. Since stock markets in emerging countries and high-yield bond markets in the United States and Europe responded the most to the Fed’s quantitative easing program, experts anticipate these markets also may respond the most strongly when tapering begins.

Weekly Fun – Think About It

“Fear comes from uncertainty. When we are absolutely certain, whether of our worth or worthlessness, we are almost impervious to fear. —William Congreve, English playwright and poet